In the realm of mergers and acquisitions (M&A), ESG due diligence has emerged as an important factor influencing the pricing of transactions.

Key Takeaways

ESG due diligence has emerged as an important factor influencing the pricing of transactions

Companies engaged in M&A recognise that overlooking ESG factors may incur regulatory fines, reputational damage, and operational inefficiencies.

Thorough ESG due diligence can uncover valuable opportunities for enhancing corporate reputation, achieving synergies, and driving innovation.

In recent years, Environmental, Social, and Governance (ESG) considerations have moved from the periphery to the forefront of corporate strategy and investment decisions. This shift is particularly evident in the realm of mergers and acquisitions (M&A), where ESG due diligence has emerged as an important factor influencing the pricing of transactions. As stakeholders increasingly prioritise ethical practices, sustainability, and transparency, the traditional financial and operational metrics used to evaluate M&A deals are being supplemented by comprehensive ESG assessments.

The growing focus on ESG is driven by several converging trends. Regulatory bodies around the world are tightening requirements on environmental and social governance disclosures, pushing companies to adopt more rigorous sustainability practices. Investors, too, are demanding greater accountability and evidence of long-term value creation that transcends short-term financial performance. Additionally, consumers are showing a strong preference for companies that demonstrate a genuine commitment to ethical conduct and environmental stewardship.

As a result, companies engaged in M&A are recognising that overlooking ESG factors can lead to significant risks, including regulatory fines, reputational damage, and operational inefficiencies. Conversely, thorough ESG due diligence can uncover valuable opportunities for enhancing corporate reputation, achieving synergies, and driving innovation.

RSM’s ESG and sustainability specialist advisers, Anthony DeCandido (US), Kathy Hobbs (UK) and Sebastian Katsch (Germany) consider a few frequently asked questions in the evolving landscape of ESG due diligence in M&A; and explore the reasons behind its rising importance to ensure successful and sustainable transactions. By integrating ESG factors into their due diligence processes, companies can not only mitigate risks but also unlock new avenues for growth and value creation in an increasingly conscientious market environment.

Frequently asked questions

1. Can ESG impact an M&A transaction?

Answer: Yes. In M&A, ESG factors are used to assess a company's sustainability and ethical impact. These factors can influence a company’s valuation, operational performance, and risk profile, making them critical during the due diligence process. It’s rarely the lead investment topic but more and more it’s being discussed during diligence. The opportunity is to connect those ESG factors that connect or retract to investment value that ultimately influences a firm’s interest and pricing for a deal.

2. Why is ESG due diligence important in M&A transactions?

Answer: ESG due diligence is important because it helps identify potential risks and opportunities that may not be evident from traditional financial analysis. This includes environmental liabilities, social impact, and governance practices, which can affect a company's long-term viability and reputation, thereby impacting the deal's success and value.

3. What are the key ESG factors considered in M&A due diligence?

Answer: Key ESG factors include:
Environmental - Climate change impact, resource usage, waste management, pollution, and regulatory compliance.
Social - Labour practices, security and privacy, community relations, health and safety, and human rights.
Governance - Board structure, risk management, executive compensation, shareholder rights, and compliance with laws and regulations.

4. How does ESG due diligence affect the valuation of a target company?

Answer: ESG due diligence can uncover risks that may lead to regulatory fines, reputational damage, or operational inefficiencies, potentially lowering the target company's valuation. Conversely, strong ESG performance can enhance valuation by demonstrating sustainability, ethical practices, and a forward-looking management approach.

5. What tools or frameworks are commonly used for ESG due diligence?

Answer: Common tools and frameworks include:
Global Reporting Initiative (GRI) Standards.
Sustainability Accounting Standards Board (SASB) Standards.
Task Force on Climate-related Financial Disclosures (TCFD) Recommendations.
United Nations Principles for Responsible Investment (UN PRI).
United Nations Sustainable Developments Goals (SDGs).

6. How can poor ESG performance impact a merger or acquisition?

Answer: Poor ESG performance can lead to several adverse outcomes, such as:
Increased regulatory scrutiny and legal liabilities.
Damage to brand and reputation.
Loss of customer and investor trust.
Operational disruptions and higher costs.
Reduced employee morale and retention issues.

7. What role do specialist advisers and third-party consultants play in ESG due diligence?

Answer: RSM’s ESG and sustainability advisers and third-party consultants provide expertise, independent assessment, and verification of ESG factors. They help identify risks and opportunities, ensuring a comprehensive evaluation that aligns with industry standards and best practices. Their involvement can lend credibility to the due diligence process.

8. What is the difference between an ESG and sustainability adviser from a professional services accounting firm and a third-party consultant?

Answer: A professional services’ accounting adviser, like RSM’s advisers, can offer both the specialist knowledge of ESG and Sustainability services including ESG due diligence and, as qualified accountants, M&A transaction advisory services and financial, risk and legal due diligence. Other third-party consultants may offer technology-based solutions or ESG and sustainability based services without the broader knowledge of the financial impact on the organisation.

9. How can companies integrate ESG considerations into their M&A strategy?

Answer: Companies can integrate ESG considerations by:
Establishing clear ESG criteria for target selection.
Incorporating ESG metrics into financial models and valuation.
Engaging with stakeholders to understand their ESG expectations.
Developing post-acquisition plans to address identified ESG issues.
Continuously monitoring and reporting on ESG performance post-acquisition.

10. What are the potential benefits of prioritising ESG in M&A?

Answer: Prioritising ESG in M&A can lead to:
Enhanced long-term value creation.
Improved risk management.
Stronger alignment with investor and stakeholder values.
Greater operational efficiencies and innovation.
Increased attractiveness to environmentally and socially conscious consumers.

11. How do regulatory developments impact ESG due diligence in M&A?

Answer: Regulatory developments can increase the importance of ESG due diligence by imposing stricter compliance requirements and disclosure obligations. Companies must stay informed about relevant regulations and ensure that their due diligence processes are robust enough to identify and mitigate regulatory risks.

It is important for companies to be aware of ESG factors and effectively prepare to incorporate these into their due diligence processes to ensure a successful transaction process through demonstrating sustainable business practices.

Contributors:

Anthony DeCandido, Partner, Co-Leader of Sustainability Service Solutions, United States

Kathy Hobbs, Associate Director, ESG and sustainability services, United Kingdom

Sebastian Katsch, Director, ESG Advisory, Ebner Stolz

This article was originally published on RSM Global